Treasurys Rise as 'Cliff" Deal Hopes Fade

Friday, 28 Dec 2012 | 4:46 PM ETReuters

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U.S. benchmark Treasury debt prices rose for a third consecutive session on Friday on safe-haven buying as hopes faded for a deal to avoid tax hikes and spending cuts that could throw the U.S. economy back into recession.

Investors are focused on Washington as President Barack Obama and lawmakers launch a last-chance round of budget negotiations days before a New Year's deadline to reach a deal. Expectations remained low a deal would be reached by the deadline.

Window-dressing for year-end and month-end extension buying also boosted demand for Treasurys on the next-to-last trading day of 2012.

"The market has lost the optimism it had over a deal getting done, it was much more optimistic a week ago," said Jason Rogan, managing director in Treasurys trading at Guggenheim Partners in New York.

Benchmark 10-year notes traded 12/32 higher in price, with yields falling to 1.69 percent, marking the lowest in two weeks and down from 1.73 percent late Thursday. Benchmark notes posted their biggest daily dip in yield in over seven weeks and were down about eight basis points on the week.

Concerns that lawmakers will fail to reach a deal to resolve the fiscal crunch by year-end are expected to keep a bid for Treasurys in the coming days, or weeks.

"I think the most likely scenario is that we will probably go over the cliff, there is a lot of posturing on both sides," said John Fath, managing partner at BTG Pactual in New York.

Many investors expect that negotiations will extend beyond Monday's deadline, with some kind of agreement likely in the first few weeks of January.

"There is the assumption that something will get done. As time continues to go on with no deal taking place I think you will start to see the market really start to get a flight-to-quality bid," said Guggenheim's Rogan.

Some fear that lawmakers are unlikely to reach a substantive consensus on how to reduce the U.S. deficit, with the most likely outcome that they will agree on smaller issues in early January and then push back negotiations on larger issues to later in 2013.

Such a delay could also increase the risk of further negative actions on the U.S. credit rating.

S&P ratings agency said on Friday it does not expect the negotiations over the fiscal cliff to have an impact on the sovereign credit ratings of the U.S. federal government. The ratings agency said, however, it did not expect to remove a negative outlook on the U.S. credit rating if Republicans and Democrats reach a short-term deal.

In August 2011, when Standard & Poor's cut the U.S. credit rating to the second highest investment grade, Treasurys rallied, though investors have said there's no certainty the market would react the same way a second time.

"The knee-jerk reaction is that there could be a move to flight-to-quality," said BTG's Fath. Longer term, he said, "there might be a bit of an illusion in the marketplace, particularly with lawmakers, that it will have no effect or bearing on rates, but at some point it will."

Fitch Ratings and Moody's Investors Service both have top triple-A ratings on the United States; all three major rating agencies have a negative outlook on the country.

Thirty-year bonds on Friday traded 27/32 higher in price to yield 2.86 percent, down from 2.91 percent late Thursday.